A few weeks ago, the U.S. stock market hit an all-time high which marked a quick recovery from the correction we experienced at the end of last year. So now what do we do? Those bulging quarterly statements are burning holes in our pockets. Enough of us were around to experience what happened at the end of the 90’s and again in 2007 when the market was exhibiting similar levels of hubris. The value of recognizing yet another high-water mark is that it should prompt some reflection on our current good fortune. Remaining in stocks but shifting to dividend-paying, low-risk investments including some bond funds can make sense at this point.
For many who have been aggressively invested in small cap funds, tech funds, and even just the 500 index or total market funds the ride has been exhilarating --- broken only by the heart-stopping decline of late last year. For new, younger retirement plan participants, that would have come as more of a shock than to those who have weathered these storms many times in the past. However, the shock didn’t last long, as the market recovered totally within the first quarter. All this means is that a new generation of 401(k) participants will have false expectations until they experience a real market tsunami and watch their accounts drop by 20 to 30 percent.
Just so you know, normal stock market cycles generally take place over four-to-seven-year cycles, so the fact that we have had a ten-year unbroken run is unprecedented. Also, when the market collapses, nobody knows for sure when the slide will end. On the way down, there are always some investors who interpret some economic (or political) event to be something that signals that we’ve hit bottom and they pile on. They turn out to be wrong, so while the market may spike momentarily, it can then resume its inexorable downward drift. This market performance pattern is commonly referred to as a “dead cat bounce.” Eventually, when it starts rising, the same group of investors will be finding all kinds of reasons why its rise can’t continue. To explain this phenomenon, we say, “the market rises on a wall of worry.”
Living through these ups and downs is a part of what we need to experience to become effective investors. The fundamental truth is that economies are dynamic engines of well-being and growth. Stock prices reflect this sooner or later which explains why, over rolling ten-year periods, the market tends to earn an average of 10% --- and sometimes more, like the 15% of the past ten years --- and the 15% per year for almost twenty years from 1980 to 1999. But some periods offer less, like the 10 years ending in 2010. This was known as the “lost decade” because the market earned a total of zero for that entire ten-year period.
This 10 percent average rate of return over longer periods is clearly a far cry above the 1 or 2 percent paid on savings or money market accounts. The only advantage of guaranteed money is the reassurance of its worth always being at least what has been invested –plus a few cents worth of interest.
By comparison, money in stocks earning 10 percent doubles every 7.2 years thanks to “the magic of compound interest” and explains why anyone investing for the future is richly rewarded over time if they can come to terms with episodes of discouragement and sleepless nights. This reward, the additional return over guaranteed money, is the so-called “risk premium” --- the additional amount of annual profit on investments in return for accepting the ride on a financial roller coaster. If this premium didn’t exist as a component of human behavior, there would be no incentive to ever take a chance and economic growth would grind to a halt.
We’re not necessarily saying “greed is good,” but putting money to work with the expectation of creating greater financial security years later makes sense for most of us.